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Class Connection: Risk Profiles

Goldman Sachs posted a decent earnings for this quarter yesterday. It reported a healthy profit of $1.66 billion and revenue of $6.56 billion (34% than its highest record) for the first quarter of this year. The reported earnings per share (EPS) of $3.23 beat analysts expectation of about $1.6 by a huge margin. The question everyone asked: Are banks back? Are they turning profitable as indicated earlier by Citibank, Wells Fargo earlier in the quarter? Some sure thought things are getting better and they helped Goldman Stocks (NYSE: GS) rise to $130 a share. But the events of the next day raised a few more questions: Are the earnings sustainable? Standard and Poor did not think so. Did Goldman report its earnings a day earlier with an hidden agenda? To help raise the stock price so that it can issue the necessary stock offering at a higher price in order to repay the TARP. One argues that the world may be going crazy. What was the nature of profits that Goldman reported? Economist and many other publications have explained this and this is exactly what we will discuss further.

Goldman Sachs profits have primarily come from their fixed income, commodity, and currency units and not from its core business, investment banking (or so it was before the bust). Goldman has made a killing during a time when companies are eager to issue bonds, with wider spreads and very low interest rates. Goldman is not only in a position of advantage, being a “big player” and with absence of competitors (remember Lehman and Bear Sterns). But what piqued my interest was this statement in the Economist’s article – “As measured by value-at-risk, a yardstick of how big your gambles are, Goldman took twice as much interest risk as a year ago. Bigger profits in part reflect bigger bets….”. This reminded me of the discussion we had had in class about risk profile and how much are you willing to gamble. If you are billionaire you may have a high risk tolerance as compared to not-so-rich. In this story we see that Goldman showed some traits of a billionaire by taking a huge risk.

This deduction begs to imply that such a risk taking attitude may not be acceptable to investors and thus might show up on the stock prices. That it did. It closed down by 11.56% today on beliefs that the earnings are not sustainable (a statement also conveyed by BlackRock’s managing director, Peter Fisher).